As cash rapidly becomes a strategic asset for corporates and asset managers, Frances Maguire looks at the outlook for 2008, post credit crisis.

The largest US companies have more than double the amount of cash on their balance sheets than when the Russian financial crisis and the subsequent collapse of Long-Term Capital Management prompted the US Federal Reserve to cut interest rates in 1998.

According to the S&P industrials (an index of large US corporates), excluding financial and utility stocks, the cash/asset ratio rose steadily each year from 1991 to 2004, and it is likely that the small dip to 8.9% of total assets in 2006 will have risen in 2007. So with cash already at record levels, how far can these levels go in 2008 as corporates seek a safe haven from the volatility of the money markets?

Stockpiling cash is a sign that businesses are unwilling to invest in acquisitions, capital improvements and expansion, due to uncertainty about economic and business conditions. Some may view a shift into cash as a prudent and timely strategic decision but unless corporates can unleash value from holding cash, even in an AAA rated bank account, there will be pressure from shareholders for dividend repayments.

Whether the a slower mergers and acquisition market will reignite remains to be seen, but while corporate treasurers hold tight and bide their time, they will want to be seen to be optimising company cash management and liquidity structures.

Tristan Attenborough, liquidity and investment product executive, Europe Middle East and Africa (EMEA), for JPMorgan Treasury & Securities Services, says there has still not been a dramatic reduction in the levels of corporate cash held. “The levels of corporate cash remain extremely high, and the events of last August will simply continue to perpetuate that. What we have clearly seen, post-crunch, is a flight to quality and to cash,” he says.

Mr Attenborough believes that if the money market crisis is put into context with the fact that corporates in general are holding near-record-high levels of cash, then the size of the issue – in terms of ensuring they properly invest cash and manage it with the right level of control and appetite for risk – is much bigger now than it would have been in previous years.

“Cash levels are already very high and clients are really looking to ensure it is being managed properly. Unfortunately, any advantage you might get from improving your cash management structure could be wiped out by putting your cash in the wrong place. There is still a lot of cash out there and August’s crisis will make corporates think long and hard about how they need to manage it properly,” he said.

There are a variety of choices in how corporates invest cash, and JPMorgan enables them to match their investment mandate with the right investment to retain control so the company is not unduly exposed, using instruments such as money market mutual funds, securities, time deposits and regular bank deposits.

Recently a JPMorgan client was looking for an alternative investment to buying US commercial paper, and the firm provided rules-based governance in line with its client’s investment strategy, which allowed it to make different investment choices. “This was a direct result of senior management not wanting the company to be overweight in commercial paper, post-liquidity crisis,” says Mr Attenborough.

Holdings to stay high

He predicts that cash holdings will stay high in 2008 given the uncertainty in the market, and corporates will continue to be very conservative in the first half of the year. Mr Attenborough adds: “They will also continue to focus on the total return they are getting from managing their assets.”

Mark Beard, head of EMEA liquidity and investments for the cash management business at Citi, says cash levels among its corporate clients have remained high. He adds: “Clients that had been previously investing in asset-backed commercial paper are not as comfortable doing so and are moving into bank accounts and bank deposits.”

Safe haven

Although Mr Beard adds that Citi’s own research, based on fours years of historical data, shows a definitive inverse link between the amount of cash held and the return on capital, the safety of cash is still proving attractive. He says: “There is definitely a drag on earnings and valuation of companies from holding excess cash, but given the uncertain credit environment, corporations may be holding on to more cash as a cushion for the short term while they see how the market pans out. There is probably good reason right now to continue to hold on to cash.”

Whatever corporates decide to do in the future, Citi is telling its corporate clients to focus on their ability to access their cash in the event they need to use it. “It is one thing for it to be showing on the balance sheet and another to have restricted access to it, especially if it is being eaten up by the business as working capital,” says Mr Beard.

The structures and mechanisms that need to be in place to minimise the cash used to run the business and to ensure the surplus is always available for strategic purposes are always going to be the essential side of cash management. Mr Beard says: “One of the simplest challenges that corporates have is actually knowing day to day how much cash they have. Many corporates feel they have reasonable visibility of 90% to 95% of their cash, but a notable minority do not have visibility on their cash daily, but only at a period end, sometimes at the end of the month. The internet is improving visibility but the consolidation of that information continues to be a challenge.”

Citi’s TreasuryVision is a web-based cash management system that provides access to third-party banks as well as cash positions held with Citi. It gives corporates the ability to mobilise that cash into consolidated structures. Launched in 2005, the system, which comprises multi-bank, multi-asset (cash, investments and debt) data aggregation, analytic reporting and treasury workflow tools, such as cash flow forecasting, was the first of its kind in the industry with the ability to aggregate these kinds of information flows into a sophisticated analytical platform.

Global pool

Mr Beard says: “The gains corporates get from consolidating their cash positions into a global pool of cash comes from the significant portfolio effect, and significant reduction in the amount of day-to-day volatility that corporates would see in their cash giving them not just greater visibility and control but a steady outlook in terms of cash, which they can better manage against.

Citi provides global zero-balancing and global, as well as multi-currency, pooling structures because its research has shown the gains are significant in terms of the cash they need to run their business, and pooling cash reduces volatility, enabling the business to manage on much less cash.

To get the real benefit of pooling, Mr Beard says it has to be a daily occurrence. So too with visibility, he adds, with intra-day reporting becoming a more common requirement among more sophisticated clients. Overnight balance sweeping can be into a single account or a notional pool. Where it is multi-currency it will inevitably be a notional pool, which can be then used as a single position by any one of those currencies. According to Mr Beard, through tools such as TreasuryVision or Citi’s Online Investing, these funds can then be placed in deposits or money market funds, with multiple providers, to optimally invest the cash.

He says: “We have experienced a notable uptake in client interest in tools such as TreasuryVision, which gives corporate clients high visibility of cash, as well as debt and investment positions, which is crucial during periods of market volatility.”

Furthermore, Mr Beard says there has been significant uptake in Citi’s multi-currency pooling products and while many corporate treasurers are already pooling common currencies, some are starting to consolidate across currencies.

In its recent 2007 Liquidity Survey, the Association for Financial Professionals (AFP) found that US businesses are maintaining high levels of cash and a significant percentage (36%) have been building their cash positions. More than a quarter (27%) of companies surveyed in August 2007 expected to increase their short-term balances over the following year.

The survey, underwritten by Citi, was conducted in May 2007 with 449 corporate practitioners responding on the strategies associated with the management of short-term investments. It reported that many organisations increased their US holdings of cash and short-term investment vehicles over the six-month period surveyed from November 2006 to May 2007.

In addition to changes in cash and cash equivalent positions, the survey asked companies about cash strategies, use of various investment tools and service providers, as well as the evolving status of cash equivalents.

Conservative mood

The survey showed that while the majority of companies polled have investment policies that allow diversity of investment vehicles beyond bank deposits and treasury bills for short-term investments, most firms remain conservative. On average they use just 2.7 different investment options for their cash and short-term equivalent balances, and they typically expect to earn up to an additional 25 basis points by investing in cash equivalents rather than cash investments. One-third of companies that invested in either auction rate securities or variable rate demand notes reduced use of these investment tools after the major accounting firms ruled that they were not ‘cash equivalents’.

Survey respondents also reported that they do not expect to make significant changes in their cash and cash equivalents balances despite the new accounting decisions and recent Financial Accounting and Standards Board (FASB) rulings to eliminate cash equivalents. The financial impact, if any, of the ruling may not be seen until later in 2008.

The survey showed that companies are permitted to spread their short-term investments across a variety of vehicles using money market mutual funds (76%), commercial paper (69%), and repurchase agreements (57%). About two-thirds of companies allow at least half of their cash and short-term equivalents balances to be placed in bank deposits, money market mutual funds, agency securities and treasury bills.

According to the AFP survey, companies’ key concerns surround the management of cash. Challenges such as obtaining accurate cash forecasts; getting real-time visibility over cash in bank accounts; consolidating cash held in multiple entities; and carrying out late-day transactions scored highly.

Thomas Schickler, liquidity and investment product executive, Asia, for JPMorgan Treasury & Securities Services, adds that at the beginning of 2007, chief financial officers (CFOs) in Asia expected their cash holdings to grow between 12% to 14% during the year, even prior to the credit crunch. Furthermore, US corporates continued to increase total cash holdings in the first two quarters of 2007.

Mr Schickler says: “In response to the liquidity crunch, we have not seen a fundamental shift in the total percentage of cash holdings. Instead, the recent market turbulence has highlighted the importance of the governance model associated with the management of cash in addition to the historical emphasis on the end vehicles in which cash is invested.”

Governance model

He says there is now much more attention being paid to the governance model than simply a shift in the fundamental structure of cash management’s sweeping and pooling strategies. “Historically, the governance model was left to the treasurer to define and manage, but the corporate CFOs are now taking a much more active responsibility,” he adds. While all corporates have investment mandates, few corporates had a dynamic toolset to monitor compliance with their investing guidelines, and it is these components that are getting more attention from CFOs and treasurers.

Mr Schickler says: “I would expect that cash holdings will increase and the rate at which they increase will grow, especially in Asia where the memory of the financial crisis in the late 1990s is still fresh in everyone’s mind. On a historical basis, Asian corporates have tended to hold a higher percentage of cash than European and US multinationals. The current market challenges will not have a material impact on Asian corporates’ cash management strategy.”

Despite the different geographical reasoning behind stockpiling cash, the end result looks the same – and it appears that 2008 is going to be a repeat performance as it has been reported that some of the largest US multinationals hold enough cash on their balance sheets to keep them going for 12 months – and, more importantly, keep them out of the costly credit market until the storm has calmed.

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